Facts  Regarding  Their  Issue  and  Their  Security 

By  Frederick  Lownhaupt 


MUNICIPAL  BONDS 

FACTS  REGARDING  THEIR  ISSUE  AND 
THEIR  SECURITY 


BY 

FREDERICK  LOWNHAUPT 
Author  of  “Investment  Bonds” 


BOOKLET  NO.  4 OF  A SERIES  ON  BONDS 
See  Page  32  for  Other  Titles 


MOODY'S  MAGAZINE 

NEW  YORK,  N.  Y. 


Copyright,  1910 

BY 

A.  W,  Ferris? 


3 3 2,6 

| L$  5T4  b 

wr.4 

. . .CONTENTS. . . 

Nature  of  Bond  ....  6 

Banker’s  Investigation  - - 7 

Territorial  Source  of  Issue  - 8 

Commercial  Considerations  - - 10 

Population  and  Character  of  Town  12 

Utilities  - - - 14 

Integrity  of  Municipality  - - 14 

Matters  Affecting  Debt  - - 15 

Debt  Limit  - 16 

Purpose  of  Issue  - - 20 

Authorization  : - 21 

Legality 22 

Marketing 25 

Investment  Position  - - 28 

P 50068 


MUNICIPAL  BONDS 


IN  consideration  of  this  large  and  prominent 
class  of  investments,  constituting  as  it  does 
fully  twenty  per  cent,  of  all  bonds  issued  an- 
nually, and  in  total  representing  a sum  ap- 
proximately three  times  as  great  as  the  entire 
bonded  debt  of  the  United  States,  or,  expressed 
in  figures,  something  like  $2,700,000,000,  it  is 
well  to  begin  with  a look  at  the  nature  of  the 
corporations  issuing  these  securities.  In  the 
generally  accepted  sense  of  the  term  when  ref- 
erence is  made  to  corporation  bonds,  it  is  in- 
tended to  convey  the  idea  of  corporations  of 
the  character  of  a railroad  or  public  utility 
concern,  though  it  is,  of  course,  true  that  mu- 
nicipalities are  corporations.  A more  concise 
definition  of  a municipality  would  be  that  it  is 
a political  sub-division  known  as  a city,  county, 
school  district,  town  or  village.  There  are  yet 
other  specially  organized  municipalities,  so- 
called,  which  are  designated  as  drainage  dis- 

5 


tricts,  levee  districts,  irrigation  districts,  etc., 
fpund  more  especially  in  the  South,  Southwest 
and  West.  Although  we  apply  to  a county  the 
term  of  municipality,  strictly  speaking  it  can- 
not be  so  considered  nor  can  any  of  thesie 
special  districts  mentioned.  Levee  and  drain- 
age districts  are  not  true  municipalities.  Thejp 
are  generally  specially  organized  pieces  oif 
territory  embracing  several  municipalities 
which  may  need  the  drainage  in  parts  or  re  - 
quire the  building  of  levees  to  hold  back  H 
river.  The  bonds  issued  by  these  districts  are 
payable  from  taxes  levied  upon  all  of  the  prop- 
erty within  their  particular  boundaries. 

Nature  of  Bond. 

What,  then,  are  municipal  bonds?  They  are 
like  Government  bonds  insofar  as  they  are  a 
promise  to  pay  based  on  the  faith  and  credit  of 
the  political  sub-division  issuing  them.  They 
are  evidences  of  debt  running  a number  of 
years.  When  a railroad  or  similar  corporation 
wishes  to  borrow  money  it  may  issue  stock  or 
borrow  temporarily  from  a bank,  but  more 
often  issues  its  bonds,  its  promises  to  pay.  A 
municipality  does  likewise  when  it  issues 

6 


bonds.  There  are,  however,  various  other  in- 
struments put  out  by  municipalities  chiefly 
among  which  are  warrants.  In  some  parts  of 
the  West,  cities  issue  these  warrants,  which 
may  be  for  salaries  owing,  payment  of  con- 
tracts, etc.,  and  are  payable  when  the  munici- 
pality is  in  funds.  Any  such  instrument  is 
essentially  local  in  its  character  while  the  true 
municipal  bond  differs  materially  from  it  in 
many  respects. 

Bankers’  Investigation. 

In  treating  of  municipal  obligations  as  in- 
vestments and  the  elements  of  their  security 
and  value  it  is  well  for  the  investor  to  keep  one 
prominent  fact  always  in  view.  This  is  the 
fact  that  the  security  has  had  a searching  in- 
vestigation by  the  banking  house  offering  it  for 
sale;  and  that  because  of  the  scrutiny  and 
analysis  to  which  the  bonds  have  been  sub- 
jected their  worth  is  established.  Further- 
more, the  banker  has  bought  them  for  himself. 
It  is  well  for  investors  to  know  the  funda- 
mental requirements  of  a good  investment,  but 
it  is  reassuring  to  know  that  the  banker  has 
thoroughly  satisfied  himself  in  every  respect. 

7 


Let  us  see,  therefore,  what  the  banker  con- 
siders in  ascertaining  the  value  and  safety  of 
an  issue  of  municipal  bonds  offered  to  his 
house.  As  we  have  said  before,  he  examines 
and  purchases  an  issue  with  a view  to  both 
buying  and  selling  well.  In  making  his  bid 
that  is  submitted  to  the  municipality  offering 
the  securities,  every  point  that  will  be  enu- 
merated must  be  considered  separately,  so  that 
the  bid  may  be  successful  from  the  two  points 
of  view  mentioned.  Should  he  not  give  due 
attention  to  every  item  some  flaw  might  be 
discovered  after  the  bonds  had  passed  into  the 
possession  of  his  clients  and  the  general  invest- 
ing public. 

Territorial  Source  of  Issue. 

Perhaps  the  very  first  point  which  is  given 
thought  and  one  that  may  be  settled  almost 
immediately  by  experience  is  that  of  the  terri- 
torial source  of  the  issue.  The  banker  knows 
well  that  the  investing  public  of  this  country 
show  considerable  partiality  with  regard  to 
location  when  contemplating  the  purchase  of 
municipal  securities,  showing  a considerable 
preference  for  older  communities  which  have 

8 


been  settled  for  some  time.  Securities  coming 
from  freshly  settled  sections  do  not  appeal  to 
conservative  investors  even  though  they  may 
be  of  excellent  value.  A town  that  is  the  direct 
result  of  a boom  would  not  be  well  considered. 
It  is  a fact  well  known  by  all  dealers  in  mu- 
nicipal bonds  that  securities  issued  by  South- 
ern towns  are  very  much  less  favorably  re- 
ceived than  obligations  springing  from  North- 
ern territory.  The  geographical  aspect  of  the 
matter,  however,  broadens  somewhat  in  the 
case  of  the  Southern  States  and  involves 
economic  factors  not  present  elsewhere.  Many 
investors  take  into  consideration  the  fact  that 
almost  half  of  the  population  of  those  States 
is  of  the  colored  race.  In  the  case  of  many 
Southern  cities,  while  the  population  may  be 
sufficient  in  numbers,  there  may  be  too  large  a 
proportion  of  negroes,  who  are  not  ordinarily 
as  thrifty  and  do  not  have  the  same  amount  of 
wealth  per  capita  as  the  white  people.  Some 
bond  dealers,  however,  do  not  put  as  much 
stress  on  this  point,  as  from  their  knowledge 
of  conditions  they  do  not  justify  the  attitude  of 
investors  in  a prejudice  against  Southern  mu- 

9 


nicipal  investments.  It  is  the  testimony  of 
these  bond  men  that  many  municipal  bonds 
from  that  section  are  now  of  a high  order  of 
safety.  Aside  from  this  sociological-economic 
factor,  a matter  of  history  influences  investors. 
Many  of  the  Southern  States  repudiated  large 
debts  just  after  war  times,  a fact  which  lives  in 
the  minds  of  many. 

Commercial  Considerations, 

If  an  issue  of  bonds  is  acceptable  on  the  vital 
point  of  territory,  a next  consideration  is  the 
commercial  conditions  existing.  A one  industry 
town  is  avoided.  As  has  occurred  in  numerous 
instances,  the  town  may  be  largely  centered 
about  the  life  and  stability  of  that  single  fac- 
tory, as  it  may  be.  The  natural  result  of  the 
vicissitudes  of  the  industry  would  be  reflected 
in  the  general  conditions  of  the  town.  Should 
the  industry  be  compelled  to  seek  another  loca- 
tion there  would  be  small  reason  for  further 
existence  of  the  town.  The  railroad  and  water 
facilities  of  the  town  or  city  are  pertinent  as- 
pects of  the  matter.  They  are  of  special  im- 
portance to  the  bond  dealer  when  considering 
the  purchase  of  bonds.  If  these  utilities  are 

10 


ample  the  stability  and  market  value  of  the 
securities  will  be  strengthened.  An  old  city  in 
a populous  community  in  which  are  located 
many  manufacturing  enterprises  of  long  and 
high  standing,  where  growth  has  been  slow 
but  steady,  and  which  has  always  met  its  ob- 
ligations at  maturity,  would  manifestly  meet 
with  easier  success  in  floating  its  obligations 
than  would  a comparatively  young  city  in  prac- 
tically a new  community  where  the  growth  has 
been  rapid./ Of  course  there  are  cities  in  the 
West  and  Northwest,  which  are  exactly  de- 
scribed in  the  last  part  of  the  previous  para- 
graph, yet  with  all  their  newness  they  are 
making  tremendous  strides  in  wealth  and 
population  and  are  the  center  of  great  indus- 
tries. Because  of  their  advantageous  location 
and  prospective  growth  their  bonds  sell  on  a 
basis  approaching  those  of  older  and  wealthier 
cities.  Care  should  be  exercised,  therefore,  to 
see  that  the  business  conditions  of  a com- 
munity are  stable  before  investing  in  its  bonds. 
It  would  be  poor  judgment  to  purchase  long- 
time bonds  of  a city  which  is  exclusively  de- 
pendent upon  such  an  industry  as  mining  for 

11 


the  reason  that  should  the  mines  give  out  the 
community  would  not  be  able  to  meet  its  ob- 
ligations. Agricultural  and  manufacturing 
communities  with  ample  transportation  facili- 
ties are  more  stable. 

Population  and  Character  of  Town. 

As  a corollary  to  the  matter  of  commercial 
importance  of  a city  or  town,  various  aspects 
of  population  are  to  be  noted.  Its  growth  for 
a few  years  past  is  studied.  It  is  advisable  to 
carefully  ascertain  from  past  reports  the 
growth  in  population  for  a period  of  say  ten 
years.  It  is,  of  course,  well  that  it  be  active 
and  growing.  Of  course  an  invesigation  of 
this  phase  of  the  question  involves  the  charac- 
ter of  the  population  and  the  town  in  general. 
Character  is  a vital  factor  in  the  matter  of  mu- 
nicipal credit.  There  is  such  a thing  as  a moral 
character  of  a city  quite  as  much  as  that  of  an 
individual.  It  is  reflected  more  or  less  in  the 
basis  on  which  a city’s  credit  stands.  As  an 
element  in  the  consideration  of  municipal 
bonds  it  is  important.  The  record  of  govern- 
ment for  some  years  previous  is  an  index.  The 
political  complexion  of  the  place  requires  at-j 

12 


tention.  Incapable  or  corrupt  officials  can 
seriously  injure  the  municipality.  Then  there 
is  the  condition  of  the  homes  and  public  build- 
ings, public  improvements,  the  condition  of 
the  streets,  sewerage,  the  commercial  pursuits 
and  the  need  of  the  utility  to  be  acquired  by 
the  bonds,  the  city’s  method  of  doing  business, 
the  advantages  the  municipality  offers  its  peo- 
ple or  prospective  residents,  and  a great  many 
other  things  which  go  to  make  up  the  character 
of  the  city. 

The  question  of  population  is  comparatively 
simple  in  nature,  attention  being  given  to  the 
number  of  inhabitants,  this  being  determined 
by  the  Federal  census  or  a certified  statement 
by  the  officials  of  the  municipality.  In  a word, 
if  it  can  be  shown  that  the  place  has  been  of  a 
steady  growth,  that  the  record  of  its  progress 
since  its  incorporation  has  been  consistently 
forward,  that  new  industries  are  locating  and 
that  old  ones  are  doing  well,  that  there  are 
ample  transportation  facilities  and  the  neces- 
sary public  utilities,  it  may  be  taken  as  evi- 
dence that  the  citizens  are  of  a progressive 
nature  and  bending  every  energy  to  advance 

13 


the  welfare  of  the  community.  The  banker 
requires  a full  record,  historical  and  otherwise. 

Utilities. 

For  the  past  few  years  the  growing  agitation 
over  the  question  of  public  ownership  of  the 
utilities  has  brought  this  aspect  of  municipal 
affairs  into  the  reckonings  of  the  bond  dealer. 
If  these  are  owned  by  a town  and  creditably 
administered,  the  assets  of  the  place  are  by  so 
much  enhanced.  Operated  for  the  distribution 
of  political  favors  and  under  the  domination  of 
politics,  as  largely  found  at  present,  they  can- 
not serve  as  a developing  influence  in  the  com- 
munity. Up  to  the  present,  experience  has 
demonstrated  that  private  ownership  of  public 
utilities  is  best. 

Integrity  of  Municipality. 

Finally,  so  far  as  determining  the  moral  and 
physical  condition  of  the  municipality  is  con- 
cerned, the  banker  will  have  regard  to  the 
promptness  in  liquidation  of  its  obligations. 
The  history  of  some  sections  of  the  country 
shows  the  evidence  of  a spirit  of  delay  and  the 
pursuit  of  dilatory  tactics  in  meeting  obliga- 
tions. A few  sections  of  the  West  were  guilty 

14 


in  years  past.  The  New  England  States  have 
always  stood  conspicuously  for  the  opposite 
policy.  With  them  it  has  been  an  anxiety  to 
pay  off  the  debt.  Municipalities  like  New 
Haven,  Conn.,  have  ever  manifested  the  great- 
est alacrity  in  ridding  themselves  of  the  obliga- 
tions. All  over  the  country,  however,  in  recent 
years,  there  has  been  a growing  tendency  to 
shorten  the  term  of  the  debt  in  period  of  years, 
or  by  paying  off  on  the  installment  plan,  that 
is,  periodically  until  the  whole  amount  is  re- 
tired. 

Matters  Affecting  Debt. 

After  some  conclusion  is  arrived  at  relative 
to  all  of  the  above  points,  other  very  essential 
matters  must  be  considered  and  satisfactorily 
regarded.  Under  one  broad  head  these  may  be 
called  the  financial  conditions.  They  include 
such  things  as  the  relation  of  the  total  debt  of 
the  municipality  to  the  assessed  valuation  of 
the  property  within  its  borders,  the  relation  of 
the  debt  to  the  total  population,  the  tax  rate 
and  the  tax  limit,  the  personal  tax  rate  and  the 
increase  in  real  and  personal  property  for  a 

15 


series  of  years  past,  say  ten  years.  Let  us  see 
what  is  the  relation  of  these  items  to  a new 
issue  of  bonds  offered. 

Debt  Limit. 

The  total  amount  of  the  existing  indebted- 
ness $nd  of  what  it  consists.  The  total  amount 
is,  of  course,  the  gross  debt,  and  is  obvious. 
The  net  debt  of  municipalities,  however,  is  not 
identical  all  over  the  country.  This  is  by  rea- 
son of  variations  of  laws  in  the  different  States. 
Part  of  the  indebtedness  is  often  created  for 
special  assessment  purposes,  or  the  building  of 
water-works,  electric  light  plants,  etc.,  and  by 
authority  of  law  the  bonds  issued  for  the  pro- 
duction of  these  utilities  may  be  excluded  or 
deducted  from  the  gross  debt  to  arrive  at  the 
total  of  net  debt.  Cities,  and  towns  are  cor- 
porations and  depend  for  their  rights  on  their 
charters.  These  charters  are  granted  by  the 
State  and  contain  certain  limitations  regarding 
their  powers. 

One  of  the  ordinary  limitations  is  the  amount 
of  debt  which  a city  may  assume  or  have  out- 
standing at  any  one  time.  In  the  State  of  New 
York  the  constitution  limits  the  amount  of  net 


16 


indebtedness  to  ten  per  cent  of  the  assessed 
valuation.  Other  States  vary  in  the  figure  set. 
They  vary  from  two  to  thirty  per  cent.,  al- 
though in  the  majority  of  States  from  five  to 
ten  per  cent.  There  is  not  so  much  variation 
in  the  percentage  of  the  assessed  valuation  that 
the  net  debt  may  represent  as  in  the  percentage 
of  the  actual  appraised  value  that  the  assessed 
valuation  represents. 

A wide  divergence  exists  among  the  differ- 
ent States  in  respect  to  the  proportion  of  the 
actual  or  appraised  value  that  the  assessed 
valuation  represents.  While  the  proportion  of 
net  debt  to  assessed  valuation  varies  from  five 
to  ten  per  cent,  the  percentage  of  assessed 
valuation  to  actual  valuation  varies  from 
forty  per  cent,  to  eighty  per  cent.,  de- 
pending upon  the  section  of  the  country. 
In  New  England  it  is  high;  in  many  of 
the  Western  States  low.  The  net  debt  of 
many  municipalities  is  arrived  at  by  deducting 
from  gross  figures  the  amounts  of  sinking 
funds  held,  in  addition  to  bonds  representing 
utilities  that  are  self-sustaining,  such  as  the 
water  debt.  In  regarding  the  financial  condi- 

. 17 


tion  of  a municipality  the  ratio  of  debt  to  as- 
sessed valuation  is  a first  consideration.  A 
financial  statement  of  a city  includes  such 
items  as  all  taxable  property,  real  and  personal, 
any  assets  which  the  city  may  have,  such  as 
water-works,  or  electric  light  plants,  any  accu- 
mulated sinking  funds.  The  assessed  valuation 
represents  the  property  value,  real  and  per- 
sonal, as  fixed  by  the  assessors  for  the  purpose 
of  taxation.  It  is  difficult  to  lay  down  a hard 
and  fast  rule  as  to  what  the  limit  of  debt  should 
be.  There  is  an  open  question  as  to  what  is  an 
excessive  debt.  This  is  a matter  which  cannot 
be  definitely  stated  as  the  varying  conditions 
of  different  municipalities  make  it  impossible 
to  pass  final  judgment  on  any  one  from  condi- 
tions existing  in  another.  In  some  places  ten 
per  cent,  would  seem  to  be  excessive  while  in 
others  even  so  high  a figure  as  twenty-five  per 
cent,  might  be  regarded  as  reasonably  safe. 
Many  bankers,  however,  look  upon  ten  per 
cent,  as  about  the  proper  limit,  beyond  which 
safety  and  security  decrease. 

It  may  be  assumed  that  whatever  limit  is  set 
by  the  constitution  of  the  respective  State  is 

18 


safe.  The  figure  of  two  per  cent,  is  what  Loui- 
siana makes,  while  in  Kansas  it  is  as  high  as 
thirty  per  cent.  New  York  allows  ten  per 
cent,  of  the  real  estate  assessment;  Pennsyl- 
vania, seven  per  cent,  of  the  real  and  personal ; 
Ohio,  eight  per  cent,  of  real  and  personal ; Cali- 
fornia, fifteen  per  cent,  etc.  In  one  or  two 
States  there  is  no  limit,  each  issue  requiring 
legislative  enactment.  The  facts  that  the  as- 
sessed valuation  is  but  a percentage  of  the 
supposed  actual  or  selling  value;  the  debt  is 
but  a comparatively  small  percentage  of  the 
assessed  valuation,  and  the  interest  on  that 
debt  from  three  to  five  per  cent,  on  an  average, 
make  it  evident  that  owing  to  the  debt  limit 
provisions,  the  interest  charges  cannot  or- 
dinarily become  large  enough  to  be  burden- 
some to  the  taxpayer.  Nevertheless,  the  tax 
rate  is  an  important  item  in  the  general  scheme 
of  a city’s  financial  showing  that  is  considered 
by  bankers.  No  city,  however  prominent  and 
wealthy,  is  inexhaustible  in  its  tax  resources. 
It  is  a fact  that  the  credit  of  a city  declines  as 
its  tax  rate  rises,  and  a deterioration  of  the 
city’s  credit  due  to  increased  taxation  might 
compel  it  to  raise  its  interest  rate. 

19 


Purpose  of  Issue. 

Again,  the  banker  having  satisfied  himself  in 
regard  to  the  general  questions,  moral  and 
physical  and  financial  in  nature,  in  regard  to 
the  municipality,  he  turns  his  attention  to  the 
bond  issue  itself.  First  of  all,  for  what  pur- 
pose are  the  proceeds  to  be  used?  This  is  very 
important.  In  issuing  a municipal  bond  it  must 
be  for  strictly  municipal  purposes.  So  long  as 
bonds  are  issued  for  water-works  plants,  erec- 
tion of  schoolhouses,  for  the  construction  of 
sewers,  etc.,  for  city,  county  and  other  public 
buildings,  and  for  various  improvements  of 
that  character  it  is  well.  They  are  then  within 
the  law.  Bonds  for  some  of  the  purposes  just 
mentioned  are  perhaps  more  popular  than 
others,  yet  they  all  find  a good  market. 

Bonds  issued  as  bonuses  to  manufacturing 
industries  are  not  favored  because  the  in- 
dustries may  not  bring  the  benefits  antici- 
pated and  because  of  an  element  of  danger  that 
the  people  may  seek  to  avoid  payment  of  the 
obligations  at  maturity.  Instances  of  this  kind 
have  happened,  as  have  cases  where  bonds 
were  issued  and  given  to  railroad  promoters  to 

20 


run  a line  through  a town.  The  railroad  never 
appearing,  the  people  have  been  loath  to  re- 
deem their  obligation.^/ These  bonds  to  en- 
courage railroads  were  most  numerous  of  all 
illegitimate  bonds  in  years  past,  but  have  all 
disappeared.  A more  recent  example  of  bonds 
for  a purpose  not  strictly  municipal  is  the  type 
issued  for  the  encouragement  of  the  beet  sugar 
industry  in  the  West.  Even  other  grossly  im- 
proper schemes  have  been  fostered  by  munici- 
pal issues  through  some  subterfuge.  The 
banker,  therefore,  finds  it  essential  that  the 
purpose  of  the  issue  be  well  established  before 
purchase. 

Authorization. 

The  authority  for  the  issue  resides  in  the  law 
- — in  the  constitution  of  the  State.  In  the  case 
of  many  of  our  larger  cities  it  is  upon  their 
charter;  in  the  case  of  counties,  school  dis- 
tricts, etc.,  upon  resolutions  of  their  respective 
governing  boards.  Small  municipalities  must 
authorize  the  issue  by  an  election.  But  in  the 
case  of  the  larger  cities  of  New  York  State  the 
measure  must  be  passed  upon  by  the  Common 
Council  and  approved  by  the  Board  of  Esti- 
mate and  Apportionment. 

21 


Legality. 

An  investigation  of  the  propriety  of  an  issue 
with  regard  to  the  points  just  touched  upon  is 
but  part  of  the  general  investigation  of  the 
total  validity,  that  is,  the  legality  of  the  issue. 
In  the  early  days  of  municipal  bonds  it  was  not 
a practice  to  make  a searching  investigation  of 
the  obligations  put  out  by  a town  or  city,  so 
that  there  should  be  no  doubt  cast  upon  them 
as  to  their  conformity  to  the  law.  It  was  taken 
for  granted  largely  that  they  were  correct  in 
every  respect.  That  the  municipality  should 
offer  them  at  all  was  ground  for  this  assump- 
tion. Frightened  more  or  less  by  the  repudia- 
tions of  a generation  ago  and  because  of  the 
specialization  that  was  developing  in  this  type 
of  security,  banking  houses  a few  years  back 
began  to  employ  expert  counsel  to  pass  upon 
their  prospective  purchases  before  paying  for 
them.  From  this  practice  have  developed  a 
number  of  prominent  and  very  expert  special- 
ists in  the  laws  governing  municipal  bonds. 
When  expert  legal  opinion  was  first  sought  in 
these  matters,  houses  began  inserting  in  their 
bids  that  the  issue  would  be  accepted  and  paid 

22 


for  only  after  a certified  transcript  of  proceed- 
ings satisfactorily  evidencing  to  their  attorneys 
the  legality  and  purpose  of  the  issue  had  been 
furnished.  While  it  is  more  general  for  the 
banking  house  to  procure  legal  opinion  of  its 
own  volition,  a few  of  the  larger  cities  through- 
out the  country  anticipate  this  action  by  sub- 
mitting to  some  prominent  counsel  a full  tran- 
script of  all  their  proceedings  to  have  the  le- 
gality passed  upon  and  approved  before  offer- 
ing the  bonds  for  sale.  Then  when  bids  are 
invited,  the  advertisement,  naming  the  counsel, 
states  that  his  opinion  will  be  submitted  to  the 
purchaser.  Yet  this  is  frequently  not  entirely 
satisfying  to  some  very  conservative  houses. 
They  have  their  own  attorney  pass  upon  all 
questions  before  or  when  offering  their  bid. 
Conditions  are  so  that  none  but  the  best  law- 
yers of  this  class  are  acceptable  to  both  banker 
and  investor.  The  notable  exception  in  this 
matter  of  attested  legality,  and  the  only  excep- 
tion, is  the  city  of  New  York.  It  will  neither 
furnish  a transcript  of  proceedings  nor  accept  a 
bid  with  any  conditions.  Accept  the  bonds  as 
offered  or  make  no  bid  is  its  ultimatum.  Any 

23 


conditions  inserted  in  a bid  invalidates  it  im- 
mediately. 

The  cardinal  qualification  of  the  attorneys 
for  banking  houses  is  naturally  a very  broad 
study  and  knowledge  of  municipal  law.  No 
two  States  of  the  Union  exactly  agree  in  many 
points.  It  is  therefore  a matter  of  large  experi- 
ence in  this  field  which  makes  their  opinions  so 
valuable.  Considering  a bond  issue  they  must 
work  along  two  lines.  They  must  see  that  it  is 
in  entire  conformity  to  the  laws  of  the  State, 
and  that  all  the  details  of  the  issue  have  been 
properly  carried  out.  This  latter  point  in- 
volves more  than  is  apparent  on  the  surface. 
Opinions  on  the  subject  vary,  but  anywhere 
from  twenty-five  to  fifty  per  cent,  of  the  aggre- 
gate municipal  bonds  are  defective  in  the  pro- 
cedure of  their  issue.  That  is  to  say,  flaws  are 
detected  by  the  attorneys  in  their  examination. 
These  defects  are,  of  course,  remedied  in  proper 
time.  Many  of  them  arise  through  ignorance 
or  inefficiency  of  the  officials  of  a town  or  city. 
Legality  is  an  extremely  important  point  with 
investors,  as  many  of  the  defaults  that  have  oc- 
curred in  payment  of  municipal  bonds  have 

24 


arisen  through  some  original  defect.  Some  de- 
faults have  arisen  through  a seemingly  impos- 
sible error-oversight  of  the  officials  in  collect- 
ing a tax  to  pay  interest.  Such  a temporary 
default,  however,  may  be  easily  cured. 

The  advertising  of  an  issue,  proper  prepara- 
tion of  the  securities,  etc.,  are  all  formalities 
that  must  be  attended  to  with  exactness. 
Should  a citizen  of  the  municipality  discover 
irregularities  in  the  issue,  he  may  obtain  an  in- 
junction preventing  the  officials  from  carrying 
out  the  operation.  If  the  case  were  serious, 
litigation  might  ensue  to  settle  the  disputed 
question. 

Marketing. 

Because  of  the  legal  restrictions  such  as  that 
one  which  is  almost  universal — the  necessity 
of  selling  at  par  or  above — some  ingenuity  is 
often  necessary  that  an  issue  may  be  floated 
when  market  conditions  do  not  warrant  so 
high  a bid.  Under  such  circumstances  it  is 
possible  for  the  bankers  to  offer  par,  but  by  ar- 
rangement have  abnormally  heavy  expenses 
which  are  paid  by  the  municipality.  This  acts 
as  a rebate  and  reduces  the  price  to  market 

25 


conditions.  Bids  vary  in  their  terms.  They 
offer  to  buy  the  bonds  on  a basis,  or,  if  a defin- 
ite interest  rate  is  stated  a firm  price  may  be 
named.  In  New  York  State  village  bonds,  by 
law,  must  be  bid  for  at  par,  with  a rate  of  in- 
terest named.  The  result  is  a variety  of  frac- 
tional rates  of  interest. 

Every  aspect  of  a bond  issue  is  more  or  less 
closely  related  to  the  market  for  that  issue. 
Generally  speaking,  municipal  bonds  have  a 
market  according  to  their  kind.  There  is  the 
broad  general  market,  the  market  that  is 
practically  within  the  borders  of  a cer- 
tain State  and  the  market  that  is  almost  en- 
tirely composed  of  institutions,  as  the  sav- 
ings banks.  It  is  easy  to  see  what  contributes 
to  make  such  distinct  markets.  The  laws  of 
many  States  make  bonds  of  municipalities 
within  their  borders  tax-exempt,  and  so  these 
are  sought  by  individual  investors.  Indeed, 
the  marketability  of  municipal  bonds  among 
these  investors  is  due  largely  to  their  tax- 
exempt  feature  in  certain  States.  Executors 
and  administrators  of  estates  buy  this  kind  of 
securities  largely.  Also  because  of  the  laws  of 

26 


States  there  is  a specialized  institutional  mar- 
ket. All  the  Eastern  States  in  their  provisions 
for  investments  by  savings  banks,  permit  the 
holdings  of  municipal  securities  with  various 
restrictions,  such  as  the  population  of  the  city, 
the  percentage  of  debt  to  the  assessed  valua- 
tion, and  the  fact  that  they  must  never  have  de- 
faulted in  the  payment  of  their  interest.  Mas- 
sachusetts, perhaps,  leads  in  the  rigidity  of  its 
requirements,  while  New  York  is  almost  as 
strict.  It  follows  that  bonds  that  can  meet  the 
requirements  of  these  States  will  enjoy  an  ex- 
cellent market.  Bankers  take  much  account  of 
the  fact  that  certain  bonds  have  only  a limited 
market.  The  question  of  market  has  a stand- 
ing objection  with  some  bonds,  particularly 
those  issued  by  cities  of  moderate  size.  As 
they  are  not  listed  or  quoted  anywhere,  the 
holder  may  have  difficulty  in  converting  them 
into  cash.  Some  possess  great  convertibility 
and  are  active,  others  possess  almost  none  and 
are  inactive,  the  determining  features  being 
the  size  and  importance  of  the  municipality  and 
the  amount  of  the  debt  outstanding. 

A restricted  or  a wide  market  is  an  important 

2 7 


question  with  the  banker  in  figuring  the  value 
of  a security,  for  a security  unhampered  by 
conditions  can  be  sold  at  a better  price.  Natu- 
rally the  bonds  of  a metropolis  are  more  easily 
marketed  than  those  of  a less  known  com- 
munity. Furthermore,  bonds  of  well-estab- 
lished cities  with  no  defaults  behind  them,  sell 
at  better  prices  than  those  of  an  unseasoned 
community. 

Investment  Position. 

Touching  upon  the  security  of  municipal 
bonds  generally,  and  their  value  as  an  invest- 
ment, there  is  everything  to  commend  them. 
That  they  are  suitable  investments  for  that 
type  of  fiduciary  institution,  the  savings  bank, 
is  prima  facie  evidence  of  their  worth  and 
safety.  They  are  a tax  lien  upon  all  the  prop- 
erty situated  within  the  boundaries  of  a mu- 
nicipality, a lien  enforceable  through  a tax  levy 
against  the  property  which  could  be  sold  under 
a tax  sale  in  case  of  non-payment.  This  is  the 
inherent  element  of  strength  in  these  bonds. 
It  is  the  imperative  duty  of  the  municipality  to 
meet  both  principal  and  interest  which  become 
a prior  claim.  Then  again  there  is  no  danger 

28 


of  an  over  issue.  The  constitutional  debt  limit 
is  of  value  here.  It  is  of  value  to  both  the  tax- 
payer and  the  bond  holder.  They  both  know 
this  is  the  decisive  check  to  officials  in  the 
creation  of  debt.  Besides  the  general  credit 
of  a city  some  bonds  may  be  a lien  on  some 
revenue  producing  public  work  such  as  a water- 
works. A bulwark  of  safety  to  the  investor 
is  the  stand  the  courts  have  taken  on  the  mat- 
ter of  repudiation.  They  will  compel  a tax 
levy  for  a valid  bond.  The  position  of  the  Su- 
preme Court  of  the  United  States  has  been 
strongly  in  protection  of  the  bond  holders. 

Municipal  bonds  generally  have  indeed  be- 
come second  only  to  Government  bonds.  The 
words  of  Judge  Dillon,  who  is  recognized  as 
the  foremost  authority  on  the  subject,  are: 

“The  Supreme  Court  of  the  United  States 
has  upheld  the  right  of  the  holder  of  municipal 
securities  with  a strong  hand  and  has  set  a 
face  of  flint  against  repudiation.  Even  when 
made  on  legal  grounds  it  may  be  found  by 
said  court  to  have  been  the  result  of  manipula- 
tions which  have  been  deceitful  and  fraudu- 
ent.  Further,  the  value  of  such  securities  is 

29 


largely  due  to  the  court’s  adjudication  in  re- 
spect thereto,  and  the  Supreme  Court  now 
warns  officials  of  all  municipalities  against  such 
manipulation,  which  is  no  fault  of  the  public, 
that  it  will  stand  firmly  by  the  decrees  that  it 
has  so  frequently  established.” 

Still  another  evidence  of  the  position  of  this 
type  of  bond  is  the  fact  of  its  acceptability  by 
the  United  States  Government  as  security  for 
deposit  of  public  money  with  the  national 
banks.  The  law  and  the  courts  set  themselves 
to  the  protection  of  the  bondholder,  neverthe- 
less, the  banker  before  offering  the  security  to 
the  public  makes  an  investigation  which 
amounts  to  a personal  investigation.  His  rep- 
resentative is  sent  to  the  town  to  make  a 
visual  examination  of  conditions.  By  spend- 
ing a few  days  in  the  town  it  is  possible  to 
confirm  previous  judgments  of  the  place. 


30 


A SERIES  OF  BOOKLETS 
Treating  The  Subjects  of  Bonds 

in  an  instructive  and  popular  manner. 


Booklet  No.  l--Railroad  Bonds. 
Booklet  No.  2--Public  Utility  Bonds. 
Booklet  No.  3--Industrial  Bonds. 
Booklet  No.  4--Municipal  Bonds. 
Booklet  No.  5--Irrigation  Bonds. 
Booklet  No.  6--Timber  Bonds. 


PRICE  TEN  CENTS  EACH 


MOODY’S  MAGAZINE 
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32 


